Theresa May’s choices are limited by the EU’s fixed menu – By Philippe Legrain for CapX

Sometimes it takes a prime minister of Luxembourg to hit the nail on the head. “They [Britain] were in with a load of opt-outs. Now they are out, and want a load of opt-ins,” said Xavier Bettel. The problem for the UK is that the European Union is much less accommodating of its demands for special treatment now that it is on the way out. To quote an American Express advertising slogan, membership has its privileges.

In her Mansion House speech on 2 March, Theresa May fleshed out the government’s “three baskets” approach to Brexit. This would involve the UK leaving the single market and customs union as promised and then diverging from EU regulatory standards to varying degrees in different sectors of the economy. In some, such as chemicals, the UK would maintain full regulatory alignment with the EU. In others, such as financial services, it would seek to achieve similar regulatory goals in different ways. And in a third basket, such as robotics and artificial intelligence, the UK would go its own way. The baskets’ contents might change over time, with the UK accepting that future regulatory divergence would entail a loss of access to EU markets.

One advantage of this approach, at least domestically, is that it is elastic enough to accommodate disparate visions of where Britain might end up after it leaves the EU. The prime minister thus achieved her immediate objective of holding her deeply divided government and party just about together for now. Hardline Brexiteers can envisage UK regulations diverging from the EU’s over time; moderates can imagine the UK remaining close to the EU. In essence, this “managed divergence” approach involves, at least initially, a soft form of hard Brexit: leaving the single market and customs union, while choosing to remain broadly aligned with the EU in many areas for now. “Sovereignty” for the sake of it.

Unsurprisingly, though, the UK’s approach is unacceptable to the EU. European Council President Donald Tusk confirmed this on 7 March when he released the Council’s draft negotiating guidelines, which require the approval of EU27 governments when they meet on 22-23 March. “There can be no ‘cherry picking’ through participation based on a sector-by-sector approach, that would undermine the integrity and proper functioning of the Single Market,” these state. (One of the unfortunate consequences of Brexit is that “cherry picking” has become part of the EU’s legal jargon. Personally, I can’t stomach any more regurgitation of cherry and cake metaphors.) On top of that, the EU believes that managed divergence would be unmanageably complex and require permanent renegotiation.

In a nutshell, the problem is this. The UK wants an à la carte Brexit: to leave the single market while choosing to keep its benefits in particular sectors and retaining the right to diverge at will. But the EU is willing to offer only a set menu of options. And given the UK’s allergy to EU judges and unrestricted EU migration, the tastiest dish left on the menu is an “ambitious” free-trade agreement only slightly better than the EU’s deal with Canada.

The good news is that both sides want their trade in goods to remain unimpeded by tariffs or quotas. That itself is already Canada Plus.

But the EU rejects the UK suggestion of a “customs partnership” that would minimise the customs frictions on their goods trade while allowing the UK to strike preferential deals with other countries. The UK proposes that it apply the EU customs code and requisite EU import tariffs to goods that arrive in the UK destined for the EU, and its own customs code and tariffs to those intended for the UK. The EU deems this technologically unworkable and ripe for abuse. Indeed, such a dual system would need to apply not just to EU-bound goods in transit through the UK, but also to UK-bound ones crossing the EU. Even Brexit Secretary David Davis concedes this involves “blue sky” thinking; the EU thinks it is pie in the sky. So the Irish border issue (and the Dover one) remain unresolved.

The EU also has no truck with the “comprehensive system of mutual recognition” that the UK is seeking. It isn’t enough for the UK to say that its standards will remain broadly similar to the EU’s in certain areas. As Michel Barnier, the EU’s chief Brexit negotiator, succinctly put it: “In the absence of a common discipline, in the absence of EU law that can override national law, in the absence of common supervision and a common court, there can be no mutual recognition of standards.” The EU has also rebuffed the UK’s bid to remain in the European Medicines Agency, the European Chemicals Agency and the European Aviation Safety Agency in some guise.

On services trade, in which the UK specialises, the EU is offering slightly better terms than it would to other third countries, notably “ambitious provisions on movement of natural persons as well as a framework for the recognition of professional qualifications”, something the UK is seeking too. President Tusk also highlighted the need for an agreement to keep planes flying between the UK and the EU after Brexit, although UK-owned and UK-based airlines will doubtless lose their right to fly freely across the Union. At a stretch, then, this is Canada Plus Plus Plus.

But the EU offer on services still falls far short of what the UK is hoping for. While the prime minister argues that, “We don’t want to discriminate against EU service providers in the UK. And we wouldn’t want the EU to discriminate against UK service providers”, the EU views such non-discrimination as a privilege of single-market membership. Its position is that UK-based services providers that wish to sell in the EU can do so by establishing a local presence – or moving there altogether – and complying with local rules. In other words, hello UK-based financial institutions.

Pointedly, the EU negotiating guidelines don’t even mention financial services, which is a top priority for UK government. As it stands, then, UK-based financial institutions that wish to sell services to EU clients would need to rely, where possible, on a unilateral and readily revocable equivalence determination by the European Commission.

To keep data flowing freely, which is crucial in pretty much every business these days, UK data protection laws will also need to mirror the EU’s in such a way that the Commission deems them “adequate”. In other words, they will need to provide a level of protection essentially equivalent to that of the EU’s mammoth General Data Protection Regulation (GDPR) that comes into force on 25 May.

To be fair, it’s not just the UK that is seeking special treatment. The EU also wants to maintain its fishing fleets’ access to bountiful UK waters. And it is demanding additional safeguards “to prevent unfair competitive advantage that the UK could enjoy through undercutting of current levels of protection with respect to competition and state aid, tax, social, environment and regulatory measures and practices”.

The prime minister says the UK has no intention of lowering its standards in these areas, but the EU is also seeking enforceable guarantees. In that important respect, the EU is seeking to impose the obligations of a Norway-style agreement in a deal offering little more than Canadian levels of market access. Is this hypocritical? Yes. Can big powers get away with not practising what they preach? Often, yes.

The negotiations this year aim to agree merely a political declaration on a future trade deal – that is, its broad outlines – with the details to be hammered out after the UK leaves the EU. Given that the UK’s managed-divergence approach is unacceptable to the EU, there is still a mountain to climb. While some of the difficult decisions can be fudged for now, the Irish border issue cannot, since it is part of the exit deal.

In her Mansion House speech, the prime minister ruled out both a hard border within Ireland and a customs border between Northern Ireland and Great Britain. Unless she is willing to revisit her current red lines, the only solution to this Brexit conundrum is the Jersey model that I recently advocated in CapX. This would involve, in effect, remaining in a single market in goods and a customs union with the EU.

As Martin Sandbu of the Financial Times has pointed out, the Jersey model is broadly compatible with May’s three baskets approach. It would involve the UK adopting EU regulations pertaining to goods trade verbatim (pursuing the same goals in the same way, in Theresa May’s terms), transposing EU directives through its own legislation (achieving the same goals in different ways) and doing what it likes on services. Short of reversing Brexit or staying in the single market, the Jersey model is the best way forward for Britain.

Philippe Legrain is a senior visiting fellow at the London School of Economics’ European Institute and the founder of OPEN, an international think-tank on openness issues.

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